Exclusive: China to guard bond investors from government shuffle

By IBT Staff Reporter On 07/29/11 AT 10:32 AM

China has ordered companies that have issued bonds to submit any asset restructuring plans to bond holders for approval, sources said, as Beijing steps up its efforts to rein in the risks from a mounting pile of local government debt.

The order by the National Development and Reform Commission (NDRC) would protect bond investors from arbitrary shifting of assets out from under the companies whose debt they have taken on. It addresses what appeared was becoming a strategy of some provincial and city governments as they start to face challenges in repaying debt they took on to pay for infrastructure and other projects.

Chinese media have reported that, as they seek to restructure loans of some local government financing vehicles (LGFVs), some local authorities have sought to shift assets away from other such entities, leaving their bond investors without the promised collateral.

The NDRC's order requires that companies that have issued bonds submit any asset restructuring plans to bond holders for approval before they proceed with such plans, two sources with direct knowledge of the order told Reuters on Friday.

It follows a rare move by one of the country's top ratings agencies to put on review for potential downgrade two financing platforms of the government of Yunnan province.

That step, by Chengxin International ratings agency, resulted from plans for a shifting of assets among Yunnan's LGFVs that could have hurt investors in two specific bonds.

It is a clear ban on random restructuring of LGFV assets, said an investment bank analyst in central China, who asked not to be quoted by name because he is not authorized to speak to the media.

These companies must from now on take responsibility (to their creditors).

Analysts saw the NDRC's step as necessary to stave off a rash of similar shuffling of assets by other local governments, at a time when the banking regulator too is trying to tighten up banks' dealing with such entities.

SORTING WHEAT FROM CHAFF

The NDRC's move coincides with the banking watchdog telling lenders that they need to step up their efforts to make sure they are able to sort credit-worthy LGFVs from those not deserving of credit.

In a recent quarterly meeting, the China Banking Regulatory Commission (CBRC) said that around 40 percent of loans to LGFVs will come due this year and next, increasing the urgency of tackling the risks arising from such debt, two sources with direct knowledge of the situation told Reuters.

The CBRC also urged banks to speed up their efforts to set up a better risk management system for making decisions on loans to LGFVs, the sources said.

Still, regulators also signaled a potential loosening of its stance, according to the sources, saying banks would still be allowed to lend to LGFVs for some projects, including for affordable housing and completing large construction projects approved by central authorities.

Recently, in a meeting that updated the situation on economic and financial situation, the CBRC pointed out that after more than a year of thorough inspection and correction of misbehaviors, there has been some success in defusing the risks arising from loans to government financing vehicles, the CBRC said in a statement in response to a Reuters query.

During the next phase, financial institutions in the banking industry should classify such loans and set aside provisions on a risk-weighted basis according to their actual cash flow situations, with a focus on reaffirming interest and principal payment clauses in loan contracts and making sure there is adequate and legal collateral.

FIREFIGHTING APPROACH

Still, there is little sign of a coordinated approach among regulators to the problem of local government debt, which officials say has hit 10.7 trillion yuan ($1.66 trillion) and which analysts say could turn into a damaging pile of bad loans.

Reuters reported in May that regulators planned to shift 2-3 trillion yuan in debt off local governments as part of a solution, but so far no official announcement on such plans has been made.

Instead, for now authorities appear to be addressing problems as they come up. Chengxin, 49 percent owned by Moody's, first highlighted the risks from such asset transfers which has now been followed up by regulators, for example.

In its directive, the NDRC also ordered local governments and shareholders of debt issuers to obtain ratings regarding the impact of any restructuring on the issuers, the sources said. Those ratings must not be lower than the previous ratings if the restructuring is to move forward, the sources added.

Under China's complex regulatory system for bond issuance, the NDRC is responsible for approving issuance of corporate bonds of one year and above by non-listed companies.

The agency also urged local economic planners to monitor the repayment of corporate debt and communicate with issuers six months ahead of their scheduled repayment of principal.

It added that bond proceeds must be used in line with the bond issue prospectus.